Archive for February, 2009

In what appears to be a page right out of the Bernie Madoff book on hedge fund fraud, money managers Paul Greenwood and Stephen Walsh are charged with bilking $550 million out of investors, state and city pension funds and higher education institutions in order to fund elaborate personal purchases that included multimillion-dollar mansions, rare books and 1,350 Steiff teddy bears.

Like Madoff, Greenwood and Walsh had been revered on Wall Street - their supposed investment prowess legendary among clients and colleagues across the country. For years, the two men succeeded in living up to the hype with claims of outperforming the Standard & Poor’s 500 Index. Their bragging came to an abrupt halt on Feb. 25, however, when FBI agents arrested them on conspiracy, securities and wire fraud charges.

The Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission brought separate civil charges against Greenwood and Walsh. In its 22-page complaint, the CFTC charged the two men of fraudulently soliciting some $1.3 billion from investors over the past decade.

Greenwood, 61, and Walsh, 64, are principals of the Greenwich, Conn.-based hedge fund WG Trading Co. LP and Westridge Capital Management in Santa Barbara, Calif. According to SEC documents, the duo conned investors with an elaborate hedge fund investing strategy that involved buying and selling equity futures and enhanced equity index arbitrage trading. 

As part of the scam, investors were told that their money was going toward “conservative” investments. Instead, court documents say the funds were used as a personal piggy bank by Greenwood and Walsh. Included in their buys: $160 million for personal expenses, $80,000 for a Steiff teddy bear (Greenwood is said to own the world’s largest collection), a $10 million property in North Salem, a $4 million home on Long Island’s Gold Coast and a 54-acre riding school and horse farm once belonging to the now-deceased actor Paul Newman.

A number of pension funds and universities are included among those who lost money to Greenwood and Walsh. The Sacramento County Employees’ Retirement System in California reportedly invested nearly $90 million with Westridge Capital Management. The Iowa Public Employee’s Retirement System invested nearly $340 million, and the University of Pittsburgh and Carnegie Mellon University collectively invested $114 million.

According to court documents, there may be as many as 16 universities or public-employee pension funds that used Westridge Capital Management as their investment advisor.

Federal authorities believe the swindle by Greenwood and Walsh could date as far back as 1996. The two men were caught only this month during a routine audit investigation by the National Futures Association. The association found $812 million in assets on the balance sheets of the pair’s hedge fund, with $794 million in promissory notes due from Greenwood and Walsh.

If convicted, Greenwood and Walsh could spend up to 20 years in prison on each of the fraud counts and five years for conspiracy. They currently remain out of jail on a $7 million bond.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

KV Pharmaceutical Co. has filed a lawsuit against Citigroup Global Markets, accusing the bank of misrepresenting the risks of auction-rate securities (ARS). KV now says it is holding $72 million of illiquid auction securities, and has been forced to borrow capital and eliminate some 700 jobs.

The St. Louis-based drug company filed the lawsuit against Citigroup on Feb. 25. According to the complaint, Citibank intentionally lied about the ARS investments, characterizing them as safe and adhering to KV’s conservative investing objectives of liquidity and capital preservation.

Between May 2005 and February 2008, Citigroup allegedly advised KV Pharmaceutical to invest in student loan-backed auction-rate securities as an alternative to money-market funds. KV says Citigroup never informed the drug maker that the liquidity of auction-rate securities may be uncertain or that auction failures were a possibility.

The complaint goes on to claim that in late summer 2007, an internal Citigroup e-mail acknowledged severe “disruptions in the ARS market” and that “failed auctions had reached at an all-time high.”

These facts were never disclosed to KV Pharmaceutical, however. Instead, KV says Citigroup recommended buying even more auction securities. Following that advice, KV purchased nearly $28 million of auction-rate securities in late November 2007.

KV Pharmaceutical’s lawsuit is the second such lawsuit filed by an institutional ARS investor against Citigroup. On Feb. 6, American Eagle Outfitters also sued the bank for fraudulently inducing it to buy $258 million worth of auction-rate securities that the Pittsburgh-based clothing retailer can now only sell at a major loss.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

It used to be common practice for hedge funds like 1861 Capital Management, Citigroup’s ASTA/MAT and Stone & Youngberg Municipal Advantage Fund to tout the promise that first built the hedge fund industry: to produce profits even in tough markets. Now it’s a different story altogether. The hype is faded, and the credit crunch has caused more banks to pull credit lines from hedge funds and investors to shun this once-popular-but-secretive corner of the investing world.

For hedge funds that invest in the $2.6 trillion municipal bond market, troubles are even more pronounced. As reported March 1, 2008, by the Wall Street Journal, turmoil in the municipal-bond market has forced a number of hedge funds to unwind complicated bets and in the process unload billions of dollars worth of securities. Among those hedge funds: New York-based 1861 Capital Management.

Municipal bond arbitrage is considered a complicated, risky investing strategy that involves trades of municipal bonds, short-term notes, and interest-rate derivatives. In recent years, a growing number of hedge funds, including 1861 Capital Management, began to employ municipal arbitrage, buying long-term municipal bonds that had slightly higher yields and pocketing the difference. The funds then hedged against large fluctuations in interest rates by essentially reversing that trade, using taxable securities. 

Municipal bond arbitrage also entails additional risk because in order to bolster returns, hedge funds must pile on the leverage.

Signs of trouble first appeared at the beginning of 2008, when municipal bond yields became hammered from the downturn in the markets. As a result, many hedge funds suddenly found themselves forced to liquidate their leveraged positions. 

It’s these two facts - risk and leverage - that have become a bone of contention for many investors in municipal arbitrage hedge funds. As reported in a January 2009 study from the Securities Litigation and Consulting Group (SLCG) on the recent failure of leveraged municipal bond hedge funds, some 36 hedge funds - 1861 Capital Management among them - were marketed and sold to investors as “high yield, low-risk alternatives” to traditional municipal bond funds.

In reality, nothing could have been further from the truth. All of the hedge funds featured in SLCG’s study contained considerably more risk than investors ever realized. They also produced significantly lower-than-expected returns. In the end, investors suffered to the tune of billions of dollars in losses.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

Times are tough for hedge funds, and they’re likely to get even tougher. Taking their lead from Capitol Hill, Connecticut lawmakers have proposed three new bills designed to dramatically shake up hedge fund business in that state with stiffer rules governing hedge fund transparency and oversight.

For years, Connecticut - which is home to hundreds of hedge funds - has taken a hands-off approach to hedge fund regulation. Until now that is. As reported Feb. 23 in the Hartford Business Journal, Connecticut’s proposed legislation would require hedge funds to obtain a state license, provide annual financial audits and disclose fees and any changes in management or investing strategy.

The plan also would bar individuals with less than $2.5 million and institutions with less than $5 million in assets from investing in a hedge fund. Stricter rules to promote transparency for hedge funds that hold investments from pension funds are an integral part of the Connecticut legislation, as well.

Connecticut’s hedge fund legislation comes on the heels of similar recommendations currently being touted in Washington. The Hedge Fund Transparency Act of 2009, which was introduced in the Senate on Jan. 29, would impose stricter regulatory oversight of hedge funds.

For years, hedge funds have operated in what many call a regulatory black hole. Despite the fact that more than 9,000 hedge funds exist today, the industry remains largely unregulated. There are no mandatory requirements for hedge fund managers to register with the Securities and Exchange Commission (SEC) or to provide detailed financial disclosures about their investing strategies.

This laxness may in part be responsible for the record number of hedge funds that shuttered in 2008. According to Hedge Fund Research, 920 funds closed down this past year. Of the survivors, the majority posted dismal performances. On average, hedge funds lost more than 18% in 2008.

Hedge funds also have been in the hot seat for their role in short selling and credit-default-swaps, both of which are at the core of the nation’s credit meltdown.

The arrest of hedge fund manager Bernie Madoff added further tarnish to the reputation of hedge funds, with many people citing the industry’s lack of transparency as the reason Madoff, who is accused of running a $50 billion global Ponzi scheme, went undetected from federal authorities for so long.

The bottom line: Heightened vigilance of hedge funds isn’t just a good idea, it’s critical if we want to protect investors and mitigate further risk to the nation’s already troubled financial system. For too long, this once-secret-but-powerful financial sector has operated under a veil of secrecy. It’s time to lift that veil.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

The Ospraie Fund. 1861 Capital Management. ASTA/MAT. Tontine Partners LP. The freewheeling world of hedge funds has crashed and burned in recent months, its fate tied to the financial crisis, investor redemptions and illiquid assets. As a result, thousands of individual investors, charities and pension fund holders are now facing unexpected and unprecedented financial losses.

The past year has seen hundreds of hedge funds go out of business. In 2008, some 920 funds were shuttered - a figure that eclipses the prior record set in 2005 when 848 hedge funds closed down. On average, hedge funds lost more than 18% last year. The previous worst performance by hedge funds occurred in 2002, posting a loss of 1.5%. In 2007, hedge funds returned 9.9%.

As hedge funds literally fought for survival in 2008, many would lose the battle altogether. Among them: The Ospraie Fund, which posted nearly a 40% loss in 2008. An even worse performance came from the Tontine Partners LP hedge fund, which ended the year down an astonishing -91.5%.

Other funds such as Tudor Investment Corp. and Citadel Investment Group LLC have been forced to limit investor redemptions or risk implosion. Earlier this month, Citadel, whose flagship hedge fund lost 55% in 2008, announced plans to resume payouts to investors. Investors’ access to their money, however, will occur no sooner than April 1.

Hedge funds that trade municipal bonds also are experiencing a rough time these days. As reported Feb. 29, 2008, by MarketWatch, problems with bond insurers and other disruptions borne out of the global credit crunch have pushed yields on municipal bonds close to, or above, those of comparable Treasury bonds. For hedge funds that try to make money from the difference, called the spread, between the yields, the end result translates into the likelihood of margin calls.

That’s exactly what happened to hedge funds like Citigroup’s ASTA/MAT hedge funds. In using a municipal arbitrage strategy, the funds ultimately were forced to sell their positions at fire-sale prices, causing significant losses to investors. 

The dismal performance of hedge funds has continued into 2009. One of the most recent hedge funds to shutter is the Highland CDO Opportunity Fund, which encountered massive losses from its holdings of high-risk collateralized debt obligations (CDOs). In October, similar circumstances forced Highland to close two other hedge funds: the Crusader Fund and the Credit Strategies Fund.

The shocking upheaval in the hedge fund industry is casting new light on the largely unregulated world of hedge funds. Registration with the Securities and Exchange Commission (SEC) is done on a voluntary basis only. At the same time, investments in hedge funds have grown astronomically. At their peak, approximately 10,000 hedge funds managed nearly $2 trillion in assets. Today, the figure is closer to $1 trillion.

On Jan. 29, 2009, a new bill was introduced in the Senate designed to improve oversight and transparency of the hedge fund industry. Described by Senators Chuck Grassley and Carl Levin as an “attempt to address securities law loopholes that enable hedge funds to operate under a cloak of secrecy,” the Hedge Fund Transparency Act of 2009 (S. 344) would make it mandatory for hedge fund managers to register with the SEC and open up their books to government examiners.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

Hidden risks and bad bets by fund managers have translated into huge financial losses for investors in the Schwab YieldPlus Fund (SWYPX). Many investors now fault the marketing techniques used by Charles Schwab Corporation, accusing the company of pitching and selling Schwab YieldPlus as a higher-yielding alternative to money- market funds.

In truth, the Schwab YieldPlus Fund was overexposed to high-risk mortgage-backed securities. That fact, as well as information regarding the fund’s concentration in toxic collateralized obligations (CDOs), was never revealed to investors. The alleged deception not only exposed investors to substantially more risk but also compromised the liquidity of the fund itself.

San Francisco-based Charles Schwab first began offering shares of the Schwab YieldPlus Fund in 1999. At the time - as is the case even today - documents and sales materials characterized the fund as “providing higher yields on cash with only marginally higher risk.” Also touted were the fund’s investments, which would primarily be made in “high-quality investment-grade bonds,” according to corporate literature on the Schwab YieldPlus Fund.

Later, investors discovered the YieldPlus Fund was far from well-diversified or low risk. Instead, more than 50% of the fund’s assets had been invested in toxic mortgage-backed securities. The fact that Schwab management also relied on investment ratings from credit agencies paid by their own broker-dealers only added to the fund’s eventual financial troubles. In addition, the net asset values of the Schwab YieldPlus Fund ultimately turned out to be highly speculative and reportedly inflated.

The Schwab YieldPlus Fund is an ultra-short bond fund. According to a Nov. 17, 2007, YieldPlus prospectus, the fund is designed to generate income with minimal changes in share price. In marketing the fund to investors, Schwab managers and the company’s own Web site highlighted the fact that the safety of the YieldPlus Fund would be enhanced by the short duration of holdings in its portfolio. Both statements would later be proved inaccurate.

For risk-averse retirees living on a fixed income, the marketing hype produced a quick sell but ultimately devastating financial results. Illiquidity and investor redemptions took the Schwab YieldPlus Fund from nearly a $14 billion fund in July 2007 to a fund whose net assets had fallen to $500 million one year later.

Today, investors who’ve suffered losses in the Schwab YieldPlus Fund continue to file arbitration claims with the Financial Industry Regulatory Authority (FINRA) in an attempt to recover their financial investments. In October, one of those investors, Jeffrey Nielson, was awarded $542,340 as part of an arbitration claim against his broker for making misrepresentations and false statements about the extent of risk associated with the Schwab Yield PlusFund.

Many believe the October 2008 ruling by FINRA could be an omen of things to come for other investors with losses in the Schwab YieldPlus Fund. In addition to the increase in arbitration claims filed against Charles Schwab for its alleged mismanagement of the Schwab YieldPlus Fund, class action lawsuits also are underway. As in the arbitration claims, the lawsuits charge Charles Schwab of misrepresenting the Schwab YieldPlus Fund as a safe alternative to money market funds and omitting key facts, including the risks tied to the fund’s high concentration of subprime holdings.

At one time, the biggest holders in the YieldPlus Fund were other Charles Schwab funds. But, in what can only be described as a true vote of no-confidence, the company said in April 2008 that no Schwab funds now held the YieldPlus Fund.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Another hedge fund bites the dust and wipes out investors. This time, massive losses on high-risk collateralized debt obligations (CDOs) have forced Highland Capital Management LP to close the Highland CDO Opportunity Fund. It is the third fund to shutter under the Dallas-based investment group since October 2008.

At one time, the Highland CDO Opportunity Fund ranked among the top 50 hedge funds, placing third in an October 2007 report by Barron’s magazine. The notoriety ended last year, however, when the fund - which previously achieved an average annual return of about 44% for three years straight - and the CDOs it invested in plunged in value.

As reported Feb. 20 by Bloomberg, Highland Capital is the largest shareholder in the Highland CDO Opportunity Fund. The firm also is considered one of the biggest players in the CDO world itself. That position, however, has suffered in recent months, as the value of CDOs continues to crumble dramatically.

In October, losses on high-risk loans and other types of toxic debt caused Highland Capital to close two other hedge funds: the Crusader Fund and the Credit Strategies Fund. Together, the funds had assets totaling more than $1.5 billion.

Now, Highland Capital is facing more problems. On Jan. 23, the Mary E. Bivins Foundation sued Highland on charges that the company reneged on a $1.8 million redemption request filed before the closing of the Highland Credit Strategies Fund. According to the lawsuit, the Amarillo-based not-for-profit invested $1.75 million in the Highland Credit Strategies Fund in 2006. Two years later, when the foundation wanted out of the fund, Highland accepted its request but reportedly delayed the foundation’s payout (valued at $1.9 million). In October, Highland announced plans to wind down the fund entirely. 

To date, only $80,000 has been paid to Bivins.

Hedge funds in general are in meltdown mode lately. The financial crisis, de-leveraging, client withdrawals and illiquid assets all have contributed to the average hedge fund losing 18.3% in 2008. About 700 hedge funds closed during the first nine months of 2008, according to Hedge Fund Research. For the entire year, 920 funds may have been shuttered - a figure that eclipses the previous record high of 848 closures in 2005.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

It’s been one year since the collapse of the $330 billion auction-rate securities market, and many investors are still no better off than they were 12 months ago. Despite efforts last summer by state and federal regulators to force investment firms and banks to buy back some $50 billion of auction-rate debt from retail investors and small businesses, ARS investors continue to hold as much as $176 billion of the illiquid investments - investments that had been marketed as safe, cash-like instruments.

One of those investors is 73-year-old Mike Stelzer. As reported Feb. 20 by Bloomberg, Stelzer envisioned plans of retiring after he sold his California cattle ranch. Instead, Stelzer is leasing land and raising cattle because a large portion of his $2 million retirement fund remains stuck in auction-rate securities.

Following the collapse of the auction-rate securities market in February 2008, investors were left with bonds they could not sell. At the time, the auction securities paid interest rates as high as 20%. Today, the rates on weekly auctioned ARS bonds pay an average of 1.36%.

As for investors, they have no where to turn because the interest on auction-rate securities is lower than what issuers would have to pay on new borrowings, giving them little incentive to refinance, according to the Feb. 20 Bloomberg article.

Today, there’s at least $85 billion in municipal securities still outstanding, according to Bloomberg. About $33 billion in auction preferred shares remain.

The $176 billion of auction-rate debt that issuers haven’t reclaimed includes more than $57 billion of auction-rate securities connected to student loans, corporations and mortgages, Bloomberg data show.

One student loan issuer affected by the auction-rate market’s woes is Brazos Student Finance Corporation. On Feb. 19, Moody’s Investors Service slashed the credit ratings on $5 billion of Brazos’ bonds backed by student loans because most are funded with auction bonds. According to Bloomberg, the interest Brazos collects on loans financed by auction-rate securities failed to keep pace with the cost of borrowing.

Meanwhile, on Feb. 11, Missouri Secretary of State Robin Carnahan dismissed a plan announced by Stifel Nicolaus to give investors holding auction-rate securities only $25,000, or 10%, of their frozen savings. Carnahan called on Stifel to immediately come up with a plan to buy back all frozen auction-rate securities from their investors, many of whom have had their savings frozen for more than a year.

After hearing Stifel’s plan, one investor called Carnahan’s office to express his frustration. “Ten percent is nothing but an insult,” said the 60-year-old investor. “If it wasn’t for Stifel’s misleading sales tactics, I would have all of my savings right now.”

Since the collapse of the auction-rate securities market in February 2008, hundreds of investors have been in contact with the Secretary of State’s office to report that they were misled by brokers who sold them auction-rate securities. Dozens of these investors filed formal complaints against Stifel specifically, saying they were promised the investments would be the “same as cash.”

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

Investor allegations of mismanagement and negligence regarding an open-ended fixed income mutual fund owned and managed by OppenheimerFunds have resulted in a class-action lawsuit against Oppenheimer and its Champion Income Fund (OPCHX).

Filed on Feb. 13, the complaint charges OppenheimerFunds and various officers and directors connected to the Champion Income Fund of violating the Securities Exchange Act of 1934, the Securities Act of 1933 and the Investment Company Act of 1940.

According to the complaint, OppenheimerFunds and its managers not only failed to exercise due diligence when it came to the Champion Income Fund but also intentionally withheld critical information about their investing strategy. Marketed as a high-yield bond fund, Oppenheimer managers began to substantially increase their use of derivative instruments in late 2006, purchasing high-risk subprime mortgage securities. Information regarding that additional risk exposure, however, apparently was never disclosed to investors until after the Champion Income Fund plummeted in value.

In December 2008, Angelo Manioudakis, the man whose gamble on toxic mortgage-backed securities and other risky structured finance deals ultimately backfired, abruptly resigned as the manager of the Champion Income Fund.

The Oppenheimer Champion Income Fund has lost nearly 80% of its value, making it the worst-performing taxable high-yield bond fund of 2008. By comparison, similar bonds were down 30%. 

Credit-default swaps also added to the losses of the Champion Income Fund. Similar to insurance contracts, credit-default swaps provide protection for investors against bond and loan defaults. In exchange for making possible payouts, sellers of credit-default swaps receive regular interest payments.

In the case of the Oppenheimer Champion Income Fund, credit-default swaps were sold on financially troubled companies like Lehman Brothers Holdings, American International Group (AIG) and General Motors Corp.  In 2008, all three firms either went bankrupt or sought financial protection from the federal government. That, in turn, had a devastating financial effect on the assets in the Champion Income Fund’s portfolio.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

An arbitration award totaling $400 million is what the Credit Suisse Group will pay STMicroelectronics NV to settle claims that it misled the semiconductor maker into buying auction-rate securities.

The Financial Industry Regulatory Authority (FINRA) announced the ARS award, which is the biggest to an investor not covered by last year’s regulatory settlements, on Feb. 13. In addition to the $400 million award, a FINRA arbitration panel also ordered Credit Suisse to pay $3 million in attorney and expert witness fees, $1.5 million in financing fees, and interest on the original value of the auction-rate securities.

STMicroelectronics’ win against Credit Suisse could be just the tip of the iceberg on auction-rate settlements, as more companies may be compelled to file claims for their losses in the investments. Said Thomas Hargett, a partner at Maddox Hargett & Caruso PC, in a Feb. 15 article on Gulfnews.com:

“FINRA’s ruling is a clear signal that there are opportunities for corporate and individual investors to recover their losses from broker-dealers. The evidence is so compelling against the major broker-dealers that sold this garbage.”

According to the complaint STMicro filed with FINRA in August 2008, the company initially wanted to invest in student-loan securities backed by U.S. government guarantees. Instead, STMicro says Credit Suisse brokers invested into high-risk collateralized-debt obligations (CDOs), many of which were backed by toxic subprime real-estate loans. Following the collapse of the housing market, those CDOs plunged in value.

Credit Suisse and its ties to auction-rate securities also made headlines in September 2008, when a federal grand jury in Brooklyn brought criminal fraud charges against two former Credit Suisse brokers who sold more than $1 billion of auction-rate securities to STMicroelectronics and other investors.

Since then, STMicroelectronics has taken a $75 million charge stemming from losses tied to auction-rate securities.

The ARS ruling is one more black mark against Credit Suisse. On Feb. 5, Erin Callan, the former chief financial officer of Lehman Brothers Holdings, announced that she was taking an indefinite leave of absence from her position as head of hedge funds at Credit Suisse. Callan has been on the job for only five months.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.